Homework

1. Ryan is an investor with a 25 percent marginal tax rate and is aware of a municipal bond that has an 8 percent yield. What yield must corporate bonds offer to match the muni bond yield of 8 percent? Explain your answer.

2. You work for Packer Investments which will invest $10 million in either junk bonds or U.S. Treasuries. Your supervisor expects a strong economy in the future. Thus, your supervisor asks you to explain what will happen to the yield spread between junk bonds and U.S. Treasuries if the economy experiences an economic boom. Explain your answer.

3. Your supervisor wants to purchase $20 million of bonds that have been issued by Titan Insurance. There are four different bond issues, but your supervisor wants to buy only one of them. He has asked you to evaluate the four different bonds and make a recommendation to him. The four bonds are have the same maturity date, same bond price, same coupon rate, same yield to maturity, and same bond rating of AAA. The four bonds do differ as follows: (a) Bond A has neither a call feature nor a conversion feature. (b) Bond B has a call feature, but no conversion feature. (c) Bond C has a conversion feature, but no call feature. (d) Bond D has both a call feature and a conversion feature. Which bond would you recommend or are you indifferent between the bonds? Explain your answer.

Use the following information for questions 4-6. Listed below in the table are Treasury yield to maturities for several different dates. The date of 01/02/2008 is before the Great Recession, the date of 01/02/2009 is during the Great Recession, and the date of 03/27/2020 is during the CO-VID Crisis. Add the 2021 numbers which were found in homework 1.

	Yield to maturity (%)
Term to maturity	01/02/2008	01/02/2009	03/27/2020	02/01/2021
0.5 year	3.32	0.28	0.02
1 year	3.17	0.40	0.11
2 years	2.88	0.88	0.25
3 years	2.89	1.14	0.30
5 years	3.28	1.72	0.41
7 years	3.54	2.07	0.60
10 years	3.91	2.46	0.72
20 years	4.39	3.22	1.09
30 years	4.35	2.83	1.29

4. For each dates listed below, report the 1-year spot rate (₀i₁), the forward rate for year one to two (₁r₂), and the forward rate for year two to three (₂r₃).

Spot and forward rates
	01/02/2008	01/02/2009	03/27/2020	02/01/2021
0i1	3.17%	0.40%
1r2	2.59%	1.36%
2r3	2.91%	1.66%
Tip: You should calculate answers for 2008 and check them against the checkpoints provided. Step 1, you select a YTM for 0i1 and compare it to the check point (3.17%). If you did not select this number, then you did something incorrectly. Figure out your mistake before you proceeding. Step 2, you calculate 1r2 for 2008 and compare it to the checkpoint (2.59%). If you did not get this number, then you did something incorrectly. Figure out your mistake before proceeding. Step 3, you calculate 2r3 for 2008 and compare it to the checkpoint. If you did not get the checkpoint (2.91%), then you did something incorrectly. Figure out your mistake before proceeding.

5. Assume there have been no events that will change investors perceptions about future interest rates and that the Pure Expectations Theory is correct. Based on the 02/01/2021 information, discuss the anticipated future 1-year interest rates over the next three years. For example, are interest rates expected to decrease or increase, and if so, by how much? Also, is there any economic news embedded in the forward rates that you can share with someone who has not studied the term structure of interest rates? Explain your answers.

6. Titan Insurance manages their money based on the Liquidity Premium Theory. You were recently hired by Titan Insurance to manage $50 million in U.S. Treasuries. Titan wants the money invested for three years at which time the Treasury securities will be liquidated and the funds used to build a new corporate headquarters. You have one of three choices: buy Treasuries with one year to maturity and reinvest the funds each year into new Treasuries with one year to maturity; buy Treasuries with three years to maturity and redeem the Treasuries at year three; buy Treasuries with five years to maturity and sell the Treasuries at year three. Assume the current Treasury rates equal the 2021 rates reported in the table above. What number of years to maturity (1, 3, or 5) do you choose for your $50 million of Treasuries? What number of years to maturity (1, 3, or 5) would you not choose for your $50 million of Treasuries? Based on your investment decision and assuming Titan Insurance is tax-exempt, how much will Titan have to spend on their new corporate headquarters in three years? Explain your answers.

7. A publication states the yield on the long-term U.S. government bond is 1.090% and it also states the interest rates or yields on several long-term securities which are listed in the table. In the following table, state the yield spread in basis points of the long-term securities relative to the long-term U.S. government bond. Also, list the characteristics that explain the yield spread and indicate whether the characteristic increases (+) or decreases (-) the return/yield of the long term securities relative to the U.S. government bond, all else equal you do not need to explain the characteristics.

Long-term bonds	Interest rates or yields	Yield spread	Characteristics explaining the differences
U.S. corporate double-A-rated (AA) bonds	1.430%
U.S. Corporate triple-B-rated (Baa) bonds	2.050%
High yield triple-C-rated (CCC)	8.370%
Municipal bonds double-A-rated (AA) bonds	0.852%
Argentinian government bonds	56.810%